In this last posting, we will look at the current situation of real estate sales and prices in the USA. At the same time, its important for us to look beyond the numbers as what we see nowadays will not be what we get.
Recently, the media reported that existing home sales rising 7.2% in July. If only the picture were as positive when you look behind the headline numbers that create the excitement. But unfortunately that is not the case.
The inventory of unsold homes rose by 7.3% in July, as many more homes came on the market than were sold. That is not a sign that the housing crisis has bottomed.
There are also reasons to believe the sales increase of recent months is temporary, since to a significant degree they were artificially driven by the $8,000 bonus being paid to first-time home-buyers. The National Association of Realtors (NAR) reports that 30% of July home sales were to first-time home-buyers enticed by the bonus. Unfortunately, the bonus program expires November 31, and given the time it takes to close a deal the NAR says would-be buyers need to make offers by the end of September. So at the end of September, six weeks away, will that high percentage of home sales to first-time buyers, 30% of total sales, go away? One would think most of it will.
It is also not encouraging that 31% of July sales were of distressed properties, those in foreclosure, often bought at auction by speculators who intend to flip them back into the market later for a profit, and "short-sales" in which the bank accepts a low-ball offer rather than put the property through the foreclosure process.
That leaves a discouragingly low level of sales that would be considered normal, sales at relatively fair value, with sellers not in a financial crisis, and buyers not subsidized by the temporary first-time buyer bonus.
There was also the discouraging news from the Mortgage Bankers Association (MBA), that the mortgage-delinquency rate rose to 9.24% as of the end of the second quarter, a new record, and that the combined rate of mortgages either delinquent or already in foreclosure rose to a record 13.16% of all outstanding mortgages.
The MBA also noted another behind the headline statistic that is not encouraging, saying, "A year ago it was subprime adjustable-rate mortgages [which were being reset at higher rates] that were causing the problems. As a sign that mortgage performance is now being driven by economic problems like job losses, prime fixed-rate mortgages now account for one in three foreclosures.
If it weren't for the probable temporary aspect of the improvement; and if we could only see consumer spending picking up elsewhere, in case this improvement in home sales is a temporary aberration, and not a sign of the recession ending.
Wednesday, September 23, 2009
Sunday, September 13, 2009
Dummies guide to crisis 2007-09 (Part 3 of 4)
In this posting and the next, we will take a look at how real estate securitization contributed to the financial crisis. The thing that governments and bankers fear the most a a bank-run. When all depositors demand their deposits back, it wont be available because the money has been loaned for thirty years on a mortgage or three years on a car loan. It can be made available only if the bank can turn its long-term loans into cash. It can be prevented only if someone quickly loans the bank cash on its assets -- or buys the assets quickly.
The problem of toxic assets is not that banks loaned too much money. In fact, the system for making loans made perfect sense. People were loaned money from depositors, but then the loans were packaged and sold to investors. The result was to return the cash to the bank that made the mortgage. Depositors were not at risk (beyond the usual risk due to fractional reserve banking).
The problem occurred at the other end. Banks thought these securitized mortgage packages were safer than the actual mortgages that they might have just held on to. Mortgages are usually excellent investments, paid without fail in about 99% of the cases and the underlying collateral -- housing -- regularly increases in price (mainly due to the steady inflation of currencies). Furthermore, risks were reduced by packaging mortgages from a variety of locations (protecting against a decline in any one city or region), organized by level of risk (riskier mortgages were packaged separately from less risky mortgages), and insured by a large international insurance company. What could be safer?
However, after 9/11, the US Federal Reserve lowered interest rates substantially to prevent the economy from freezing up or spiraling into a recession. The low interest rates caused housing prices to rise at an unusually high rate for several years. Then, perhaps in part because housing prices were rising so rapidly, suggesting inflation that was not being observed in the US Consumer Price Index, which does not include housing to any appreciable degree in its calculations, the Fed reversed course. This began a collapse in housing prices as the higher mortgage rates sharply reduced demand.
So these securities, presumably safe packages of insured loans, suddenly were hit from all sides. First, interest rates were rising, which made the old mortgages (and the related securities) decline in value since investors preferred the higher rates now available. Second, because housing prices were now declining, the value of the underlying collateral was declining as well, making the securities less secure. Third, because some buyers had bought property with adjustable rate mortgages, the rising rates and lower housing prices caught them in a trap; they could not refinance, and there was a steady increase in foreclosures. Fourth, a recession in the US was beginning, threatening loss of jobs and more foreclosures.
Now, what seemed an advantage -- securitization and insurance -- was reversed. Prior to securitization, the value of the mortgages on a bank's books was fairly clear. If it was being paid, it was valued at face value. If not, it was in foreclosure and had a reduced value based on the costs of foreclosure and resale. Typically this might mean the bank's mortgages were valued at 99.5% of their original value. In a crisis, with many foreclosures, this might drop to 97%, but that would be unlikely. In the case of a run on the bank, it could get cash for its fully valued mortgages.
However, with securitization, there was a market for the securities. Because there were a great many securities each with thousands of different loans, after the first sale was made to an investor, usually to an institution, not many actual resales occurred. Now, however, because it was unclear which securities included mortgages in the greatest danger and which did not, the very small number of sales saw prices that were extremely low -- less than 50% of the face value of the securities.
Now, the banks had a new problem. They had bought these securities themselves (not the smartest move, but it seemed safe), and the securities had to be valued, not on the grab-bag of underlying assets, but on the recent sales of such securities at fire-sale prices, an accounting rule called "marked to market".
Although foreclosures represented only a few percent of the mortgages, the practice of marking to market and the limited number of buyers for the securities dropped the value of these bank assets by 30-70%. The banks were suddenly insolvent -- as were all those who had insured them and other financial institutions against losses -- including all the investment banks.
So, in this situation, what should be done? If the banks failed, the depositors were secured by the FDIC, in theory. However the FDIC, despite its name (Federal Deposit Insurance Corporation) was a private corporation funded by a small insurance fee paid by banks. It's assets would be exhausted by the first few banks that failed. It could not pay more than a tiny fraction of depositors if there were a run on the banks.
Thus, to avoid a collapse of the banking system, the US Treasury and Federal Reserve began sticking fingers in the dike. It pressured the accounting body to eliminate mark-to-market, and at the same time, cut deals to give money to the insurance companies and banks.
The hasty effort to stop the panic may have prevented a collapse, but it did not slow the overall decline. People now became more afraid, worsening the housing price decline and the recession. Furthermore, since little or nothing has been done to preserve the value of the underlying mortgages (something that could have been done with a government guarantee of the principle and interest), the value of the assets continues to decline, requiring further bailouts.
The problem of toxic assets is not that banks loaned too much money. In fact, the system for making loans made perfect sense. People were loaned money from depositors, but then the loans were packaged and sold to investors. The result was to return the cash to the bank that made the mortgage. Depositors were not at risk (beyond the usual risk due to fractional reserve banking).
The problem occurred at the other end. Banks thought these securitized mortgage packages were safer than the actual mortgages that they might have just held on to. Mortgages are usually excellent investments, paid without fail in about 99% of the cases and the underlying collateral -- housing -- regularly increases in price (mainly due to the steady inflation of currencies). Furthermore, risks were reduced by packaging mortgages from a variety of locations (protecting against a decline in any one city or region), organized by level of risk (riskier mortgages were packaged separately from less risky mortgages), and insured by a large international insurance company. What could be safer?
However, after 9/11, the US Federal Reserve lowered interest rates substantially to prevent the economy from freezing up or spiraling into a recession. The low interest rates caused housing prices to rise at an unusually high rate for several years. Then, perhaps in part because housing prices were rising so rapidly, suggesting inflation that was not being observed in the US Consumer Price Index, which does not include housing to any appreciable degree in its calculations, the Fed reversed course. This began a collapse in housing prices as the higher mortgage rates sharply reduced demand.
So these securities, presumably safe packages of insured loans, suddenly were hit from all sides. First, interest rates were rising, which made the old mortgages (and the related securities) decline in value since investors preferred the higher rates now available. Second, because housing prices were now declining, the value of the underlying collateral was declining as well, making the securities less secure. Third, because some buyers had bought property with adjustable rate mortgages, the rising rates and lower housing prices caught them in a trap; they could not refinance, and there was a steady increase in foreclosures. Fourth, a recession in the US was beginning, threatening loss of jobs and more foreclosures.
Now, what seemed an advantage -- securitization and insurance -- was reversed. Prior to securitization, the value of the mortgages on a bank's books was fairly clear. If it was being paid, it was valued at face value. If not, it was in foreclosure and had a reduced value based on the costs of foreclosure and resale. Typically this might mean the bank's mortgages were valued at 99.5% of their original value. In a crisis, with many foreclosures, this might drop to 97%, but that would be unlikely. In the case of a run on the bank, it could get cash for its fully valued mortgages.
However, with securitization, there was a market for the securities. Because there were a great many securities each with thousands of different loans, after the first sale was made to an investor, usually to an institution, not many actual resales occurred. Now, however, because it was unclear which securities included mortgages in the greatest danger and which did not, the very small number of sales saw prices that were extremely low -- less than 50% of the face value of the securities.
Now, the banks had a new problem. They had bought these securities themselves (not the smartest move, but it seemed safe), and the securities had to be valued, not on the grab-bag of underlying assets, but on the recent sales of such securities at fire-sale prices, an accounting rule called "marked to market".
Although foreclosures represented only a few percent of the mortgages, the practice of marking to market and the limited number of buyers for the securities dropped the value of these bank assets by 30-70%. The banks were suddenly insolvent -- as were all those who had insured them and other financial institutions against losses -- including all the investment banks.
So, in this situation, what should be done? If the banks failed, the depositors were secured by the FDIC, in theory. However the FDIC, despite its name (Federal Deposit Insurance Corporation) was a private corporation funded by a small insurance fee paid by banks. It's assets would be exhausted by the first few banks that failed. It could not pay more than a tiny fraction of depositors if there were a run on the banks.
Thus, to avoid a collapse of the banking system, the US Treasury and Federal Reserve began sticking fingers in the dike. It pressured the accounting body to eliminate mark-to-market, and at the same time, cut deals to give money to the insurance companies and banks.
The hasty effort to stop the panic may have prevented a collapse, but it did not slow the overall decline. People now became more afraid, worsening the housing price decline and the recession. Furthermore, since little or nothing has been done to preserve the value of the underlying mortgages (something that could have been done with a government guarantee of the principle and interest), the value of the assets continues to decline, requiring further bailouts.
Tuesday, September 8, 2009
Showing at a cinema near you! (In the near future)
New characters from the Disney-Marvel merger........ :-)
IRON MOUSE!
SPIDER MOUSE!
IRON MOUSE!
DONALD HULK!
SPIDER MOUSE!
Friday, September 4, 2009
Heads you win. Tails I lose!!!
I have to interupt the dummies posting with this latest development from one of the S-chip companies. The majority owner of China Precision has decided to take the company private by offering S$0.28 to buy back all existing shares it does not not own. I am not a stakeholder in China Precision. Nevertheless, ALL MINORITY SHAREHOLDERS SHOULD REJECT THIS OFFER!
Why do I say that? Below are some reasons which i believe will support my view.
1) The company's IPO took place in May 2006 at a price of S$0.30. The exit offer is at a discount of 6.7%. This means that shareholders who held on to the shares since IPO will make a loss (lets exclude the dividends for the time being).
2) As of the latest financial report ending 30th June 2009, the net asset value (NAV) of the company is S$0.32 per share. Based on this, the exit offer is at a discount of 12.5%.
3) Currently, China Precision does not have any bank borrowings. Thus, the assets mainly consist of cash, property and plant equipment. It has RMB 143 million of cash which translate to a cash backing of S$0.08 per share. In short, the majority owner is only paying S$0.20 for the whole business.
4) For HY2009, the company made earnings of RMB 9 cents for each share. Using the exchange rate of S$1:4.5 RMB, the EPS is S$0.02. Assuming the EPS does not change, we will have S$0.04 for the whole year. Setting the exit offer at S$0.20 (minus the cash backing) means that the business is only valued at a forward P/E of 5X (Isn't that cheap?).
I will be looking forward to the response from the independent directors and the appointed financial adviser on this exit offer. Its time for shareholders to sit up and vote wisely.
Why do I say that? Below are some reasons which i believe will support my view.
1) The company's IPO took place in May 2006 at a price of S$0.30. The exit offer is at a discount of 6.7%. This means that shareholders who held on to the shares since IPO will make a loss (lets exclude the dividends for the time being).
2) As of the latest financial report ending 30th June 2009, the net asset value (NAV) of the company is S$0.32 per share. Based on this, the exit offer is at a discount of 12.5%.
3) Currently, China Precision does not have any bank borrowings. Thus, the assets mainly consist of cash, property and plant equipment. It has RMB 143 million of cash which translate to a cash backing of S$0.08 per share. In short, the majority owner is only paying S$0.20 for the whole business.
4) For HY2009, the company made earnings of RMB 9 cents for each share. Using the exchange rate of S$1:4.5 RMB, the EPS is S$0.02. Assuming the EPS does not change, we will have S$0.04 for the whole year. Setting the exit offer at S$0.20 (minus the cash backing) means that the business is only valued at a forward P/E of 5X (Isn't that cheap?).
I will be looking forward to the response from the independent directors and the appointed financial adviser on this exit offer. Its time for shareholders to sit up and vote wisely.
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